Sunday, April 15, 2012

Jonathan makes Austrians sound like Keynesians who think the Fed kept rates too low for too long in the 2000s

Here. And Greg Ransom applauds him which is a big flashing red light to me that something is wrong here. To me, ABCT is Wicksell plus Bohm-Bawerk, while Keynesianism is Wicksell plus Marshall. Taking the Bohm-Bawerk out of ABCT and just talking about capital theory the way most non-Austrian neoclassicals talk about capital theory seems like something different to me.

It ultimately doesn't matter what you call it. To me, this means that Jonathan is closer to the way I think about the economy (he just worries about price distortions at slightly different points in the business cycle). But it does make me wonder where Hayek has gone in all this.

I know that it is said that generalized problems occur across more and less roundabout points in the capital structure. That's precisely why I asked what we can and can't look for empirically. But let me quote an article of Jonathan's that he links to in this new blog post:

"What triggers the revelation of this incomplete investment, oftentimes described as "malinvestment," is a consequent rise in the price of consumer goods relative to capital goods. That capital deepening did not come at the expense of consumer demand but instead was made possible by an artificial increase in loanable funds, suggesting that the initial fall in the price of consumer goods that should have otherwise taken place did not actually occur. Consumer-goods prices will also rise as a factor of an increase in the price of labor, a product of an increase in the demand for labor as a factor of production, and as a result of a possible diminishing in the stock of capital goods, as some nonspecific goods are used in earlier stages of production. The rise in the price of consumer goods catalyzes the abrupt shortening of the structure of production, revealing a mass of malinvestment."

OK, so there obviously isn't a single "capital structure". Different industries have different periods of production. Andrew Young and others have shown that the length of the period of production does vary over the business cycle as Hayek suggested. Hayek's reason was related to the intertemporal coordinating role of the interest rate (which - I should add emphatically - we all agree on, we just all haven't made the contribution of applying it to the question of the length of the period of production the way Hayek did). When there is this "abrupt shortening" that Jonathan refers to, entrepreneurs are realizing that the price signals of the earlier monetary injections into the loanable funds market were actually giving a misleading signal about the value of time. Time is actually more costly than they thought. This ought to make a lot of particularly long produciton processes less profitable. Production processes that are shorter by their very nature shouldn't take as much of a hit because less of their costs are tied up in the cost of time - which was revealed to be distorted by the moentary authorities.

Now clearly this is going to have a broad impact. If workers in longer-period-of-production-industries are out of work they're going to buy less of everything, including goods from shorter-period-of-production industries. This criticism is fine and makes sense to me, I just wanted to clarify that that wasn't the only thing going on. But even in that case, I would think we would still see less of an impact on industries with naturally shorter production periods, whose profit margins are less contingent on the misinformation provided by the interest rate.

I guess I'm just wondering how this is really "Austrian". I'm thinking about ABCT more again and I'm thinking along the lines of contrasting "Wicksell + Bohm-Bawerk" with "Wicksell + Marshall", but Jonathan seems to be suggesting that is the wrong approach. I'm not sure I'm convinced.

16 comments:

  1. Interesting post, Daniel Kuehn. You also might want to check out this review on Amazon.com regarding Hayek, Keynes, and the Production Possibilities Frontier.

    http://www.amazon.com/review/R3VZLHAHIQ9LUR/

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  2. Böhm-Bawerk was improved upon by his successors. Hayek made important improvements on Böhm-Bawerk's work, and Mises rejected the concept of more "roundabout production." Mises took a much harder subjectivist approach to capital theory, and Lachmann, in some ways, unifies the two approaches. So does Rothbard, I think, but I haven't read Man, Economy, and State yet. What I wrote is not a personal interpretation, I don't think. I pretty literally follow Hayek's Prices and Production, while influenced by Mises and Lachmann.

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  3. I also consider myself pretty thoroughly Austrian and have an interpretation of what that means that is incredibly similar to Jonathan's. I would make sure "downward stickiness," for a lack of a better term, in the capital structure was expressly introduced, but that's about it.

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  4. I think this is the issue Jonathan is trying to get too....

    In Garrison's explanation of ABCT two things happen. Firstly, more of the very high order goods are produced, and secondly because of expectations of greater profits later demand for consumer goods rises and more of the low order goods are produced. Then, we get the broken Hayekian triangle where the middle parts isn't consistent with the left and right sides. That is, not enough of the goods of intermediate orders exist to satisfy the demand for consumer goods that will occur later.

    One of the problems with this model is that it only accounts for some of the aspects of ABCT. One thing it misses is the rate at which existing high-order capital is turned into consumer goods. For example, lets suppose that we have an economy where there is no possibility of roundaboutness changing. In that case we can't have normal ABCT. But, the aggregate price of existing capital can still vary compared to the aggregate price of output. That means monetary fluctuations can still affect output. For example, suppose the value of minerals in mines is very sticky compared to other prices. In that case when monetary expansion occurs output from mines will increase. If other prices, like wages, are stickier then other outputs may increase.

    Would Keynes agree with that? He probably would, but so would Hayek. This issue is a place where Keynesians and Austrians are concerned about similar things.

    I still think that empirical testing of ABCT would be useful and that this problem can be overcome. It's a tricky issue and one I could write a lot more on.

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    1. I didn't base my argument on Garrison's model. Only on Hayek's Prices and Production and articles published during the 1930s. Check out this graph from Hayek's "Capital and Industrial Fluctuations" (1934): http://images.mises.org/4924/Figure1.png

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    2. I was just explaining in terms of Garrison's ideas.

      Do you agree with what I say above, is that what you mean by "Malinvestment is about aggregate investment" or do you mean something else?

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    3. I only meant that the volume of aggregate investment requires a certain supply of capital goods; but real savings have not risen fast enough to fulfill that demand, and so we see an intertemporal discoordination -- this is the origins of malinvestment (this is what the above-referenced graph depicts).

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    4. Jonathan Catalan,

      You may be right. Do you have a post about this issue on your blog? I don't understand the one Daniel links to.

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  5. When there is this "abrupt shortening" that Jonathan refers to, entrepreneurs are realizing that the price signals of the earlier monetary injections into the loanable funds market were actually giving a misleading signal about the value of time. Time is actually more costly than they thought. This ought to make a lot of particularly long produciton processes less profitable. Production processes that are shorter by their very nature shouldn't take as much of a hit because less of their costs are tied up in the cost of time - which was revealed to be distorted by the moentary authorities.

    This is a great explanation and I agree with all of it.

    Böhm-Bawerk was improved upon by his successors. Hayek made important improvements on Böhm-Bawerk's work, and Mises rejected the concept of more "roundabout production." Mises took a much harder subjectivist approach to capital theory, and Lachmann, in some ways, unifies the two approaches. So does Rothbard, I think, but I haven't read Man, Economy, and State yet. What I wrote is not a personal interpretation, I don't think. I pretty literally follow Hayek's Prices and Production, while influenced by Mises and Lachmann.

    This is not such a good explanation and I don't really agree.

    The crucial concepts as defined by Bohm-Bawerk were definitely carried on by Hayek, Mises and Rothbard (No comment on Lachmann). Bohm-Bawerk was improved, of course, but only marginally. Mises did away with one or two conclusions by Bohm Bawerk in his entire corpus of capital theory (the notions of capital productivity theory of the interest rate and the "average period of production); not most or even a lot of it. The Bohm-Bawerkian picture of capital formation is pretty darn good.

    Hayek made lots of advancements with Bohm-Bawerkian ideas as they relate to theories on competition and entrepreneurship (Prices and Production was a theory on the relationship between stages of production, profit margins, and entrepreneurial judgment). Mises made lots of contributions, too. But Bohm-Bawerk was never replaced or refuted - he was the foundation stone for Hayek, Mises, and Rothbard - who incidentally includes Bohm-Bawerkian theory a lot in chapters 5-9 of Man, Economy, and State.

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    1. That's good, because I never said Böhm-Bawerk was "replaced" or "refuted." ;)

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    2. I pretty much agree with Mattheus here and disagree with Jonathan. Though I think this is bringing us further away from the point.

      In my view Mises doesn't abandon the concept of roundabout production.

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    3. And I wouldn't call some improvements "marginal," unless you define what you mean by that. All improvements are marginal: all improves add something to a greater body. But, some improvements made by Mises and Hayek were crucial, and some differences between Mises and Hayek are also crucial.

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    4. Current,

      Mises was very careful not to make absolute statements with regards to capital intensity and roundaboutness -- he took a much more subjectivist approach to entrepreneurship and the business cycle. He thought there was more to consider than only changing prices between different stages of production, even though on-the-whole he understood that this was the main mechanism behind the business cycle. These subtle differences are important, because it gives us a more accurate idea of how the structure of production will tend to change during episodes of credit expansion.

      I'm not sure what there is to disagree with me. Mattheus didn't really say anything that suggests I'm wrong. Much of what he implicitly accuses me of saying, I never did (such as that Böhm-Bawerk was "replaced" or "refuted").

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    5. I got an impression that you thought Mises and Hayek had "moved on" from Bohm Bawerk and left him in the dust. Mises and Hayek were strong Bawerkians.

      By marginal I meant in terms of size. The improvements to capital theory per se were small (No comment on Pure Theory of Capital). They made substantial contributions to business cycle theory and macroeconomics using his developed capital theory, but they did not, in my estimation, travel much further than Bohm Bawerk in capital theory directly.

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    6. That both Mises and Hayek were heavily entrenched in Böhm-Bawerk's work doesn't mean that in some respects they did "move on." Making improvements doesn't mean imply a change in paradigm, just an advance in the ways they thought about some specific topics. It makes sense, too, because in many ways Böhm-Bawerk remained a Ricardian, and there were some elements of his work that had to be "modernized."

      In our case, I don't think you can separate business cycle theory from capital theory (in terms of co-development). I think some of the improvements made were definitely because of the focus on the business cycle, but there were changes in how these economists perceived the allocation of goods throughout the structure of production took place. Many of these changes were crucial, in that they provided a much more accurate capital theory. I think Hayek took on a much more formal approach, similar to Böhm-Bawerk, while Mises approached it from a less formal, more subjective angle (which is also why I think -- and I have read similar accounts -- Mises never really deeply elucidated on the theory of capital).

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  6. Neither do I think the concept of the cost of time as central as it's made out to be in this post. Credit expansion doesn't necessarily have to lead to longer production processes by part of individual firms. What lengthening the structure of production means is that new stages will be added. This is not a reference to the time period of production for individual processes; rather, there will be an increase in demand for inputs -- entrepreneurs will produce these inputs, increasing demand for earlier inputs. Entrepreneurs can decide what techniques to use.

    This is why the topics of the Cambridge capital controversies don't really apply.

    What an abrupt slowing or ceasing of credit expansion does is allow relative prices to shift in accordance with the new capital stock, revealing that a lot of this demand was made possible by new money. When these inputs are no longer demanded, the structure of production has to be shortened.

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